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Wednesday, December 5, 2012

A Fistful of Euros


After one of the longest episodes of can kicking in history, the Eurogroup decided to kick the can even further down the road for Greece. Further assistance for Greece has been approved, though releasing funds is still subject to conditions being met by Greece. This issue has been a major drag on financial markets for over two years. A failure in Greece was speculated to lead to a failure in Spain, Portugal, and Italy, which some analysts felt would lead to a break-up of the Euro, and a return to old currencies. A few studies seem to suggest a financially stable country, such as Finland, could willingly leave the Euro, though at the moment that appears to be very unlikely. While there are still many details to resolve, the more immediate issue of the collapse of the financial system in Greece has been pushed ahead a few years. I'm not convinced the growth projections and turn-around prospects are realistic, especially given the culture of tax evasion, corruption, and cronyism in Greece. The Greek news daily Ekathimerini ran the full Eurogroup statement without comment. The big items in the deal made for Greece involve a relaxing of the previous fiscal targets and lowering the debt-to-GDP target amounts, while extending the time period for recovery. As noted in our previous articles, an extension of time for Greece will be a drag on Europe, as more funds will be needed over a longer time period. Greece will receive up to €43.7 billion (Euros) in several stages, with the first instalment set for 13 December 2012. Reviews will happen quarterly, as long as Greece can maintain repayment schedules for previous bail-outs. Part of the latest deal involves a buy-back of Greek debt at a fraction of the previous value, which is supposedly voluntary to avoid triggering a technical default. The details of how the Greek debt buy-back will function have yet to be released.

The Euro gained following the announcements on Greece, and most major European stock markets moved upwards to new 2012 highs. If you hold shares in European companies, you may have seen some gains recently. It may be tempting to think that with the Greek debt issues resolved, markets can now move to more realistically reflect economic conditions. However, the Greek story will continue to come back into focus every few months for many more years, especially if the political balance shifts in Greece towards an anti-bailout emphasis. The current group in power in Greece ran on the promise of renegotiating debt conditions, though they barely achieved any of the concessions the politicians promised the public. I think it is far too early to claim that a bottom has been reached in European markets, and I would expect some pullback in early 2013. Greek debt-to-GDP will still be 124% by 2020, and even that may be a wildly optimistic target. Politicians in Europe may imagine they are avoiding problems in bond markets for Spain and Italy, though throwing money at Greece and expecting a 65% improvement in the Greek economy by 2020 does not seem rational. While Greece gets some relief in 2013, there are still major changes needed to their economy to get back on track towards growth. The debt buy-back will be a key aspect of the 2013 turn-around. Fitch Ratings stated that the debt buy-back is not a credit event, meaning it should not trigger sovereign Credit Default Swaps (CDS) on Greece, though this only applies if the debt buy-back is voluntary. Moody's Ratings downgraded the credit rating of the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF) largely on funding concerns from France, whom Moody's recently downgraded; though another issue is that the ESM and EFSF funds may be used to provide funding for the Greek debt buy-back. Matina Stevis of the WallStreet Journal has a great article about the Greek debt buy-back. She points out that €9.6 billion (Euros) in funding will be needed to entice private Greek bond holders to sell back their bonds at a loss. The sticking point in this is that there is no provision in the bail-out package to provide €9.6 billion in funds. Some analysts think this funding may come through the EFSF. Supposedly if the debt buy-back does not go smoothly, there is a Plan B, though so far no Eurogroup officials have provided any details. Early indications are that participation in the debt buy-back may be greater than expected, though investors must make clear their interest before 7 December 2012, and the final details will be revealed 17 December 2012.
FinViz - One Month EquitiesDuring the month of November, the S&P 500 opened at 1412.20, and finished the month at 1416.18, trading in a range from an early month high of 1434.27 and a mid month low of 1343.35. Continued low trading volume made for some interesting moves, though essentially markets failed to rally. Most investors could have ignored this month and probably came out at about the same level in which they started. Obviously concerns surrounding the U.S. elections, and some global concern over a change of leadership in China, kept some institutional investors out of the markets, which contributed to the low trading volumes. Some of the large investment companies in the market, like Paulson & Company and Soros Fund Management, released 13-F filings that indicated they increased their holdings in gold ETFs and gold futures over the previous quarter. Oddly enough, the recent declines in gold futures are rumoured to be due to Paulson & Company unloading gold positions to meet client redemption requests. Warren Buffett hired two new fund managers forBerkshire Hathaway (BRK.A) and their recent 13-F filing with the SEC (Securities and Exchange Commission) indicated new positions in Deere (DE) and Precision Cast Parts (PCP). It is important to remember that 13-F filings show past activity. A large investor decreasing positions in some companies may not necessarily be a cause for concern, nor should purchase activity be an indication to buy shares in a company. You can find the latest complete SEC 13-F filings at the following links for Berkshire HathawayTudor InvestmentsSoros FundsThird Point LLC, and Appaloosa Management. We might get a false sense of optimism after viewing the holdings, though most of these large funds tend to hold shares for long periods of time. It is more common to find pessimism amongst smaller investors, often due to uncertainty. While there is nothing wrong with being a cautious investor, it is good to avoid the doomer mentality as defined by Bill McBride of Calculated Risk. McBride points out that in 1994 Larry Kudlow (of financial news network CNBC) predicted that Clinton tax increases would lead to a severe recession, or even a depression, though we now know that prediction was wrong. Business Insider recently interviewed Bill McBride, and pointed out several of McBride's correct predictions over the years, including the bottom of the housing market in March 2012.
Thanksgiving holiday retail sales did not appear to be as robust as expected, with many retailers putting forward deals to lure shoppers. While it appeared there were more people shopping, in-store sales declined about 1.8% compared to 2011. On-line and mobile shopping finally displaced in-store shopping for a significant portion of shoppers. Sales on-line increased 17% over 2011, while the big Cyber Monday on-line shopping day sales improved 30% over 2012. Even in New York City, still recovering from Hurricane Sandy, package deliveries appeared to indicate robust on-line sales. It's a good sign for recovery in New York City, though other areas are still struggling with the clean-up after the hurricane. In some of the hardest hit areas, some homeowners are trying to sell homes at depressed prices, while others search for available rental units. The number of displaced people due to Hurricane Sandy is placing a large demand upon rental units in the region. Fitch Ratings notes that the impact of Hurricane Sandy complicates accurate near term outlook for the United States economy. There are also Fiscal Cliff concerns, though Fitch thinks this will be avoided, placing U.S. growth at 2.3% for 2013 and 2.8% for 2014.
Case-Shiller Index and Phoenix Existing Home SalesIn housing markets, private equity companies and hedge funds appear to be reviving housing as an investment. One area of interest for some private equity investors has been non-agency mortgages, with returns of over 30% this year in some deals. Another investment segment tied to this activity is direct purchases of houses, with some analysts estimating thatover $6 billion may go towards investments in single-family homes. About 20% of October homes purchases are estimated to have gone to investors. Asking prices on properties appears to have increased in November 2012 in some regions, though mostly in the hardest hit areas. This may be an indication of a change in demand, or simply investors looking for alternatives to placing funds into stocks or bonds. Rents are climbing upwards in many cities, though unevenly compared to home ownership price changes. Jed Kolko at Trulia Trends has more figures on asking price gains and rental rate increases across the U.S. Research firm Core Logic (CLGX) note that home prices increased 6.3% in October 2012 compared to October 2011. November projections are for a 7.1% increase over the previous year. Core Logic notes that the greatest price gains, excluding distressed sales, have been in Arizona, Hawaii, Nevada, Idaho, and California. When data for distressed sales was included, home prices actually declined 40.2% in Nevada, and decreased 36.6% in California. Obviously distressed home sales are still causing a drag on home price gains, though Mortgage Resolution Partners have an unusual idea for clearing out distressed properties using eminent domain. In an interview with Reuters, CEO Steven Gluckstern outlined the process of using eminent domain, and where it stands now. It's important to point out that his company is approaching this from an economic viewpoint, and he points out that one of the biggest issues is principal reduction. It's an interesting 8 minute video interview, and highly recommended viewing. The Federal Housing Finance Agency (FHFA) is currently opposed to this plan, though Mortgage Resolution Partners are pursuing this at a regional level on a small scale. Currently, theShadow Inventory of distressed homes in the United States is estimated to be between 2.3 million and 6 million homes. While we have some improvement in home price levels, we saw a slight decline in new home sales in October 2012 to 368k, and figures for September were revised downwards to 369k, a decline of 0.3% month to month. Some of the decline may be due to Hurricane Sandy, since the northeast United States experienced a 32.3% decline in new home sales. Luxury home builder Toll Brothers Inc. (TOL) recently reported improved earnings, and noted their back-log climbed more than 54%, which suggests a recovery in housing is underway. Competitors D.R. Horton (DHI) and KB Home (KBH) also recently reported better earnings and outlook.
Latest ISM figuresIn ongoing Fiscal Cliff negotiations, one possible change suggested by the President would be a reduction or elimination of the mortgage interest deduction. While that obviously would affect the housing market, the exact way in which such a change would be implemented has not been outlined. Politicians look set to fight up until 21 December 2012, which would normally be their recess break for the year, though there is some potential politicians may continue meeting beyond that point. Given the recent slowdown in manufacturing in November, with ISM (Institute for Supply Management) figures falling to 49.5 (a reading below 50 indicates a contraction of factory activity), any delay by politicians could have a large impact at the beginning of 2013. This is the lowest ISM survey since July 2009. If a deal is reached on the Fiscal Cliff, then we may reasonably expect a rebound in manufacturing activity in early 2013. There has been some discussion that a two step deal may be put in place, which would throw further negotiations on the Fiscal Cliff into August 2013. Chinese factory activity recently increased slightly, after a mid-year slowdown. Combined with slowdowns in Brazil, Europe, and Southeast Asia, it should not be surprising that markets have stagnated and mostly traded sideways. A strike by dockworkers at the Port of Los Angeles is not helping matters, as cargo ships sit and wait to be offloaded. Along with the Port of Long Beach, this area is the largest container port in the United States, and the seven days (so far) strike is estimated to impact the economy at a rate of a Billion dollars a day. Until a clear direction on the Fiscal Cliff is in sight, we may expect somewhat muted movements in stock markets. Housing appears to be the one bright area in the economy, though the overhang of the large Shadow Inventory could take many years to resolve. As long as we stay flexible and diversified, we may find ways to continue to generate profits in the future.
G. Moat